CHAPTER 7
Marginal Utility
The additional utility a person receives from consuming an addi tional unit of a good.
Consumer Equilibrium
The equilibrium that occurs when the consumer has spent all of his or her income and the marginal utilities per dollar spent on each good purchased are equal.
Behavioral economists believe that they have identified human behaviors that are inconsistent with the model of men and women as rational, self-interested, and consistent:
(1) Individuals are willing to spend some money to lower the incomes of others, even if doing so lowers their own incomes. (2) Individuals don't always treat one dollar as one dollar: some dollars seem to be treated differently than others. (3) Individuals sometimes value X more if it is theirs than if it isn't theirs and they are seeking to acquire it. (4) The way a set of options is framed (presented) can matter to the choices individuals make.
Utility
A measure of the satisfaction, happiness, or benefit that results from the consumption of a good.
Util
An artificial construct used to measure utility.
Interpersonal Utility Comparison
Comparing the utility one person receives from a good, service, or activity with the utility another person receives from the same good, service, or activity.
Individuals seek to equate marginal utilities per dollar.
For example, if a person receives more utility per dollar spent on good A than on good B, she will reorder her purchases and buy more A and less B.
The law of diminishing marginal utility should not be used to make interpersonal utility comparisons.
For example, the law does not say that a millionaire receives less (or more) utility from an additional dollar than a poor man does. All it says is that, for both the millionaire and the poor man, the last dollar has less value than the next-to-last dollar has.
A good can have high total utility and low marginal utility.
For example, waters total utility is high, but because water is so plentiful, its marginal utility is low. In short, water is immensely useful, but it is so plentiful that individuals place relatively low value on another unit of it. In contrast, diamonds are not as useful as water, but because there are few diamonds in the world, the marginal utility of diamonds is high.
On the one hand, a good can be extremely useful and have a low price if the good is in plentiful supply (high value in use, low value in exchange);
On the other hand, a good can be of little use and have a high price if the good is in short supply (low value in use, high value in exchange).
Law of Diminishing Marginal Utility
The marginal utility gained by consuming equal successive units of a good will decline as the amount consumed increases.
Diamond-Water Paradox
The observation that things with the greatest value in use sometimes have little value in exchange and things with little value in use sometimes have the greatest value in exchange.
Total Utility
The total satisfaction a person receives from consuming a particular quantity of a good.
The diamond-water paradox states that what has great value in use sometimes has little value in exchange
and that what has little value in use sometimes has great value in exchange. A knowledge of the difference between total utility and marginal utility is necessary to unravel the paradox.
The law of diminishing marginal utility holds that,
as the amount of a good consumed increases, the marginal utility of the good decreases.
Behavioral economists argue that
some human behavior does not fit neatly—at a minimum, easily—into the traditional economic framework.
Marginal utility analysis can be used to illustrate the law of demand, which states
that price and quantity demanded are inversely related, ceteris paribus.